NEW DELHI: The finance ministry proposes to lift the ceiling on investments by pension funds in stocks and debt mutual funds, potentially freeing up about Rs 1.5 lakh crore that could flood the capital markets, already riding high on optimism that the new government will effect an economic turnaround.

The proposal seeks to allow pension, gratuity and provident funds to invest 30% of their corpus in equity and up to 40% investments in debt mutual funds regulated by the Securities & Exchange Board of India.

The government had first opened up the equity investment window for retirement funds in 2005 by allowing a 5% allocation to stocks and expanded this to 15% in 2008.

There is currently around Rs 10 lakh crore parked in retirement funds in the country and, theoretically, the decision to hike the limit to 30% will make it possible for an additional Rs 1.5 lakh crore to be invested in the capital markets.

The actual figure will however be less as the Employees' Provident Fund Organisation (EPFO), which runs the country's largest retirement fund, has so far not invested in equity.

According to the finance ministry's proposal, half the funds that are pumped into equity can be invested in shares of firms traded on the futures and options segment of the bourses and equity-linked savings schemes of mutual funds.

A new investment category has been created to allow another 15% of the corpus to be invested in exchange-traded funds or index funds that track the two leading indices in the country — the NSE Nifty and the BSE Sensex.

The new norms for pension fund investments could also give a boost to the cash-strapped infrastructure sector as they permit investments in infrastructure debt funds and asset-backed securities. Infrastructure projects in the country have suffered for the want of long-term financing to match their lengthy gestation periods — a gap that is globally covered by retirement funds with investment horizons of 30-35 years.

The finance ministry also plans to reduce the maximum exposure of retirement funds to government securities from the present 55% to 40%, leaving them with little option but to look for other investment opportunities such as equity.

The changed norms, on which the ministry has invited comments before they are notified, could significantly boost retirement incomes of around 8.75 crore workers covered under EPFO and millions of others whose firms offer them benefits such as gratuity and superannuation pension.

EPFO has a corpus of around Rs 6.5 lakh crore.Since 2012, the finance ministry, which oversees EPFO, to liberalise its investment norms as it was relying excessively on government bonds and delivering negative returns after inflation.

Though EPFO's board of trustees has steadfastly refused to approve any investment in stock markets since 2005, there is a growing realisation within the body and among some board members that the annual return of 8.5% it has delivered to its members in recent years is woefully inadequate to keep up with high inflation.

In addition, the finance ministry is also set to tweak the conditions for investments in term deposits of scheduled commercial ban ks in a bid to ensure that fund flows from large pension funds such as EPFO don't dry up for 24 major public sector banks like State Bank of India and Punjab National Bank.ET had reported last week that the high non-performing assets (NPAs) of these banks had made them ineligible for investments by pension funds.

The present guidelines don't allow investments in deposits of banks with net NPAs over 2% of net advances.